Sandy Leeds’ Analysis of Key Market Issues

The Great Disconnect: Employment vs. GDP

2012 April 1

by SJ Leeds

Last Monday morning, Fed chairman Bernanke gave a speech titled, “Recent Developments in the Labor Market.” It was an early morning speech (before the market opened). Here’s the link. Market commentators attributed the market’s 160 point Monday rally to Bernanke’s comments. There was one main takeaway…monetary policy would stay accommodative.

Personally, I think it would be more exciting to see the market rally because of earnings or strong fundamental news. It’s less exciting to think that the market is rallying because money is cheap and will stay cheap.

Regardless, I think that Bernanke’s comments were much more interesting than simply “viva la low rates.” In today’s blog, I want to describe the most interesting things he said. If you want more details (and who wouldn’t?), here’s a pdf of an outline that I wrote about the speech. It will take just a few minutes to read and the back of the pdf file includes all of Chairman Bernanke’s slides.

Now, the short version of Bernanke’s key points…

1. There’s no question that there’s some good news in the labor market. Payrolls have increased almost 250K / month for the past three months, there’s been a significant increase in aggregate hours worked, the unemployment rate has dropped, household expectations have improved, business hiring plans have improved, new claims for unemployment insurance have decreased and measures of breadth of hiring across industry have improved.

2. There are still many negative signs in the labor market. Private payrolls are still five million jobs below peak (plus the population has grown). The unemployment rate is well above a sustainable level (and 3% above the 20 year average). Total hours worked are below pre-crisis level. Long-term unemployment is very high. We’ve seen more of a decline in layoffs than an increase in hiring.

3. Okun’s law suggests that we need to have GDP growth 2% higher than our potential growth (for one year) in order to lower unemployment by 1%. As a result, it seems like the positive employment numbers are not in sync with the pace of expansion.

4. While the decrease in the participation rate has had an impact, we have seen a drop in the unemployment rate of marginally attached workers to the same extent as the overall unemployment rate. This indicates that the “weak” are getting jobs at the same rate as the overall population. This story contradicts the idea of the weak simply dropping out.

5. The increase in employment reflects a catch-up from outsized job losses during recession. Employers feared that the economy was going to be even worse than it turned out to be. In addition, they may have feared a credit crunch, so they tried to conserve cash. Employers are simply getting back to normal staffing.

6. To the extent that we’re just recovering from “over-firing”, we need high growth to lower the unemployment rate further.

7. The high percentage of people who have been unemployed for longer than six months reduces our productive capacity over the long-term. We have a loss of skills. It could also slow our rate of recovery in the short-term because it takes longer to match these people to jobs.

8. It takes older workers longer to find new jobs. This is a structural unemployment problem that has been raising our unemployment rate because a larger percentage of our labor force is older (the aging baby boomers).

9. Since we need higher growth to regain jobs, this can be supported by continued accommodative policy. In addition, if our unemployment is generally cyclical (rather than structural), this also speaks to continued accommodative policy.

10. Even if the unemployment problem is mostly cyclical, if it continues on for too long, it can become structural. Skills can atrophy.

Have a great week.

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About

Sandy Leeds, CFA is a Distinguished Senior Lecturer at the McCombs School of Business at The University of Texas at Austin. He teaches graduate level classes in the MBA program and also serves as President of The MBA Investment Fund, L.L.C.
Prior to teaching, he had careers as a lawyer and a money manager. He did his undergraduate work at The University of Alabama and also has a law degree from The University of Virginia and an MBA from the University of Texas. At UT, he has received many teaching awards, including Outstanding Professor in the MBA Program.
He is married and has three children.